US Tax Court cases in a nutshell. There are so many ambiguous areas of the tax code in which the IRS falls back on the old stand by "we'll consider all the facts and circumstances to determine if your position on a tax return should be supported." Tax court cases show us the IRS in action doing just that! (Please note that blogs may include sections copied directly from court case decisions found at ustaxcourt.gov)

Tuesday, January 24, 2012

The 'Just Horsing Around'' Case

Anyone running a business that is something others may list as a hobby can learn a lot from this case! An endeavor (breeding Welch ponies and cobs) that taxpayer’s treated as a business was found to be a ‘an activity not engaged in for profit’ (a.k.a a hobby) and therefore 5 years of losses were disallowed. The court ruled that they were enthusiasts not bona-fide breeders. Taxpayer’s lone sale of a horse in this 5 year period was to a not-for-profit for $500 and they took a charitable contribution of $5000 which they claimed was the remaining value. Expenses were substantial. Over a 10 year time period they claimed almost $840k in losses.

Take aways:

• To prove profit motive, “the goal must be to realize a profit on the entire operation, which presupposes not only future net earnings but also sufficient net earnings to recoup the losses which have meanwhile been sustained.” This throws cold water on the theory that a couple of profitable years will evidence a profit motive in spite of a number of loss years.

• Taxpayers conceded that their research showed that in order to become profitable as horse breeders, given the high boarding costs, they would need to own a facility. Yet, they continued to acquire more horses while incurring very substantial annual losses, suggesting “an indifference to those losses that we are unable to reconcile with an actual and honest objective of making a profit.”

• Activities that have a clear recreational aspect are likely to draw IRS attention when reported as businesses with repeated losses.

• Taxpayers listed a dog on the depreciation schedule and $1100+ in dog expenses. This was cited as evidence of how loosey-goosey the taxpayers were in relation to keeping their personal and business expenditures segregated. They also used a standard pro-ration of 80/20 for everything indicating that everything was estimated.

• The court pointed out that the purpose of keeping business records is not only to “memorialize transactions for tax reporting purposes.” Rather, bona fide business people use these records to help them improve the performance of the business over time. This is part of what is considered when determining whether or not a profit motive exists.

• Someone who is really in the business of breeding horses would keep records about each horse and these taxpayer’s did not. Additionally, although some appreciation of horses was possible, it is inconceivable that they might be enough to recoup the cumulative losses since the start of the business.

• There have been cases where horse ownership was deemed a hobby even when the horses were boarded by the taxpayers.

• Although taxpayers utilized a paid preparer, the court noted that there was no evidence that they either sought or relied on his advice in relation to the appropriateness of their treatment of this activity as a business. (Both seeking and relying on advice of a competent professional are required for any hope of avoiding the accuracy-related penalty on these grounds.)

• Taxpayers depreciated the horses, further negating their claim that they were held for sale. Inventory/stock in trade is not depreciable.